Goldman thinks oil prices could fall another 50% as the market spends another year sorting itself out

The oil market is out of whack and Goldman Sachs doesn't see this
situation sorting itself out for another year.

In a note to clients on Friday following
OPEC's latest production announcement, Goldman's Damien
Courvalin wrote that the oil market's supply-and-demand balance
won't be restored until the fourth quarter of 2016 at the
earliest.

On Friday, OPEC — the 13-member oil cartel — announced that it
will look maintain its current rate of production at around 31.5
million barrels per day. (Goldman, for its part, expects OPEC
production to come in closer to 31.8 million barrels per day.)

BAML

OPEC also said it would discuss how to accommodate higher
production out of Iran at its next meeting in June.

Goldman added that OPEC commentary, "further stressed the need
for the oil market to rebalance on its own ('wait and watch') and
the organization made no comment on adhering to country level
quotas."

This approach from OPEC, however, could send oil prices even
lower as markets may still fail to clear oversupply.

Here's Goldman:

For now, our price forecast reflects our belief that
"financial stress" can solve the current market imbalance by
gradually reducing excess supply capacity as demand recovers. We
believe, however, that there are high risks that this may prove
too slow an adjustment as inventories continue to accumulate and
storage utilization nears high levels in the face of a mild
winter, slowing EM growth and a potential lift of international
Iranian sanctions.The rising probability that
markets may need to adjust through "operational stress,"when surpluses breach capacity,leaves
risks to our forecast as skewed to the downside in coming months,
with cash costs near $20/bbl."

And so while Goldman is forecasting oil prices over the next few
months to be near $40 a barrel, or roughly where they are trading
today, there could be another 50% to fall as continuing OPEC
production pushes producers toward the absolute lowest level they
can conceivably manage.

While much has been made of the "breakeven" cost of oil
production over the last year, it is the "cash cost" that
determines the actual floor for oil producers. The "breakeven"
cost measures what oil price producers need to be profitable, the
"cash cost" measures the absolute lowest level a producer can
accept to keep their operation running (even if at a loss).

And as this chart from Bank of America shows, the cost of pumping
oil has gone down as technology increases have made things much
more efficient.

BAML

The strategy that has been employed by OPEC over the last few
years as US shale production has ramped up has been to push ahead
and seek to both bring in as much revenue as possible by simply
selling oil at prevailing market prices and hoping to push out
smaller, marginal producers as a result of these low prices
created by an oversupplied market.

In other words, OPEC has been content to play chicken with US
producers.

But as long as investors remain willing to invest in oil
companies that are operating above their "cash cost" level, then
it won't be financial stresses on the company level that allow
markets to clear, but stresses at the storage level that might be
needed for the market to balance.

And as we see in this chart from Bank of America, there are signs
physical storage capacity for oil is simply running short.